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When Is Bank Regulation Really Bank Protectionism?

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The simmering controversy over American Express' (AXP) Bluebird card typifies a classic debate: When do regulations that ostensibly protect the public from shady operators really just protect incumbent businesses from competition?

The card, sold at Walmart (WMT) stores, has features that arguably make it competitive with checking accounts (including paper checks), but it is not FDIC-insured. Amex issues the product through its Travel Related Services unit, which is licensed by the states as a money transmitter – not through either of its federally supervised depositories.

Some suggest Amex is going out on a limb, offering a product that is a checking account in all but name without the usual safeguards for depositors. "Can Amex operate as an uninsured bank under the laws of 50 states, selling checking accounts untouched by bank regulation? I doubt it," wrote BankThink's resident curmudgeon, the veteran industry consultant Andrew Kahr, in his column last week.

The knock on Bluebird is that if something were to happen to American Express, customers could lose money. For its part, Amex points out that under the state money transmitter laws, it must hold assets to back up 100% of the funds on the Bluebird card at all times. As if on cue, company officials reply to questions about the product with the same response: Amex has been issuing travelers checks out of the TRS unit for more than a century. For whatever it's worth, American Express and the TRS unit carry investment-grade ratings from all the major credit agencies (and TRS' ratings are higher than the holding company's).

As my colleague Joe Adler reports, there's a broader debate going on about whether prepaid cards in general should be required to carry FDIC insurance. Unsurprisingly, those in favor of such backing include bankers.

To some, this smacks of cartelism. "Is there no end to the tyranny of the banking industry?" reader Jim Wells wrote in a comment thread. "First banking sycophants criticized prepaid cards as second class products and no substitute for bank relationships. Now that consumers have ignored this nonsense and embraced prepaid cards over predatory bank accounts, bank apologists are invoking the argument of requiring FDIC insurance. What's wrong with a little honest competition in the financial services industry?"

From this perspective, the Bluebird card might be viewed as what the tech entrepreneur and investor Chris Dixon calls a "regulatory hack."

"Many regulations are created by incumbents to protect their market position," Dixon wrote in a recent blog post. But "startups don't have the resources to change regulations through lobbying. Instead, they need to start with regulatory hacks: 'back door' experiments that demonstrate the benefits of their ideas. With luck, regulators are forced to follow."

For example, Dixon writes, in the early days of cell phones, when the FCC limited the market to two operators per city, the company that later became Nextel got around this barrier "by acquiring local (e.g. taxi, pizza truck) dispatch radio companies, which they then connected to create a nationwide (non-dispatch) cell phone service. Predictably, the cellular incumbents tried to regulate Nextel out of existence." Among other claims, "the incumbents argued that Nextel's service would interfere with public safety frequencies and therefore endanger the public."

The FCC ultimately permitted Nextel's service, which flourished, without harm to consumers. "The only thing endangered [was] the incumbents' profits," Dixon writes.

For some observers, such protectionism is the sole or main purpose of most or all regulation. Mitt Romney's statement during the first presidential debate that "you couldn't have people opening up banks … in their garage and making loans" angered these laissez-faire advocates. "There's no reason that the same kind of garage-style innovation that brought growth and dynamism to the technology, toy, and bagel businesses can't also penetrate into lending," wrote Ira Stoll in Time magazine.

Yet Dixon also acknowledges that "regulations that truly protect the public interest are necessary." And I know I used the following line while discussing this theme in American Banker's Morning Scan a few weeks ago, but it bears repeating: "You wouldn't want to use an unlicensed brain surgeon, would you?" Well?

Not all lines are so bright, however. How do we know when a regulation is "truly protecting the public interest," and when it's merely protecting a cartel? What are some examples of the latter in financial services? Even if Amex's Bluebird pushes the legal envelope, is anyone really getting hurt? And why shouldn't people be allowed to open banks in their garages – provided they put a "NO FDIC GUARANTEE" sign on the door? Let us know your thoughts in the Comments section below.

Marc Hochstein is the Executive Editor of American Banker. The views expressed are his own.

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Comments (5)
With Bluebird letting customers avoid a fee, with among other requirements, requiring direct deposit... the ultimate goal of getting the wages deposited, I think they are raising the regulatory bar on the card. The politicains and the regulators should be very interested when peoples paychecks are fully deposited with WalmartExpress.

I have not seen the privacy disclosures, but if data sharing goes back to Walmart, that is an entire financial view back to a retailer. That pervassive a view has not existed to my knowledge, espically in the hands of the largest retailer in the world that prides itself on IT use and advantage. The politicains and the regulators should be very interested when peoples every inflow and outflow are given to WalmartExpress.

We are in a time low rates. What happens when these become interest bearing accounts as rates rise....

Can I garnish this card...
Posted by mthompson | Monday, October 22 2012 at 5:14PM ET
Credit and payment services should be attenuated to the needs, service quality, efficiency, affordability, and convenience of the "customer". As noted in the article above, the banking industry has - over time - effectively exercised one of Porter's main methods of competition: creating "Barriers to Entry" through exploiting the regulators and legislators in Washington DC (read Porter's work under "Threat of New Entrants"). If the legislators and regulators were truly sensitive to the needs of the public, Wal-Mart would've had a bank charter long ago. SunTrust has been placing branches inside Wal-Mart stores for years. This is great, but imagine how much additional convenience would be provided to customers if Wal-Mart could bank those customers directly. Banks hate the idea because they would get dis-intermediated by a better platform. This has NOTHING AT ALL to do with what is best, what is manageable, or what makes sense for the public. It is, as described, protectionism.

Moreover, a Wal-Mart charter, much less Bluebird, could be very effectively handled by the FDIC and the CSBS with an eye towards Title II of the Dodd-Frank Act (DFA) - i.e., the Orderly Liquidation Authority (OLA). Last week, former House Banking Chair Frank issued an eloquent defense of DFA, with an appropriately long-winded explanation for why OLA is needed and why a rationalized legal entity structure is helpful in a crisis. He also emphasized the unfair pricing (i.e., thanks to TBTF and, perversely, the designation of the SIFI/G-SIFI moniker by the FSOC) that the large banks enjoy, a "government sponsored entity" subsidy courtesy of DFA that is even LARGER NOW than prior to the crisis.

A Wal-Mart banking charter would help fix some of the legal entity issues, if managed well. Each bank could be state chartered and all credit and deposit taking ring-fenced to customers (retail) domiciled to that state, as well as separate IT facilities. In a failure, the depository could be easily cleaved off. Moreover, with Wal-Mart competing against the lazy cartel banks, the requirement for better competition could be a real needed push for this highly protected industry.

Salute to Amex, and may the forces of goodness, free-competition, and fairness attend your every move. May the dark forces of cartelism, political favoritism, and collusion be exposed for what they are: a gift to an industry used to being coddled and protected by the legislators they help put into office and the regulatory leadership that are the lap-dogs of those same cartel-minded people. May all financial pain accrue to the G-SIFI banks, and may regional and community banks thrive. If the Amex effort materially harms regional and community banks, then figure out a way to solve that and proceed.
Posted by Stentor | Monday, October 22 2012 at 8:04PM ET
Great article Marc. The OCC and OTS protected the national banks they were supposed to be supervising for so long, the banks came to believe they could ignore state consumer protection laws. So it surprised no one that these regulators opposed the CFPB and national banks continue to spend billions lobbying against regulatory reform.
Posted by jim_wells | Tuesday, October 23 2012 at 8:09AM ET
This reminds me of the pat excuse big Japanese companies fall back on to oppose reform: that it will create "confusion" in the marketplace and among consumers. As long as risks are well disclosed, consumers should have as much choice as possible--including in prepaid cards. The lack of an FDIC backstop certainly has not kept the money market business from growing. Neil Weinberg, Editor in Chief, American Banker.
Posted by Neil Weinberg | Tuesday, October 23 2012 at 12:12PM ET
As the Exec Editor of AB, I admire your commitment to common sense in this article vs. industry protection logic. However, you let me down in the end when you justify regulation with, "You wouldn't want to use an unlicensed brain surgeon, would you?" Well?"
What does "want" have to do with government regulation? If I don't "want" to have brain surgery from any surgeon, I don't have to. If the government approves brain surgeons, then I "can't" have brain surgery done by unlicensed individuals. Does that make me as a consumer better off? If regulation takes away choices from the consumer, how is that good for the consumer? The only non-protectionist justification for this is that it protects the ignorant. Really? Do we really think the government makes more intelligent choices for people than people can make for themselves? I don't think so, and I think the rule applies to bankers, brain surgeons, and lots of other facets of commerce that suffer from manipulation by special interests who use big government to increase their advantage. In short, government regulation protecting me from harming myself is a farce, an excuse for organizations to protect themselves at the consumer's expense. Governments have enough to deal with regulating choices I might make that could harm someone else. THIS is where regulation is necessary! Regulating me from dumping raw sewage upstream from my neighbor's drinking water source would be a better example of necessary government regulation.
Posted by jmt8066 | Wednesday, October 24 2012 at 9:10AM ET
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